Designing the Buyer-Supplier Contract for Risk Management: Assessing Complexity and Mission Criticality

In this study, we argue that contract design is a predominant strategy to set contractual expectations among supply chain partners to manage risk. We draw upon resource dependence theory and transaction cost economics to suggest that variation in risk management strategies is dependent upon both the complexity of the procured product or service and the extent to which it is mission critical. In this preliminary study of public-sector supply chains, we find evidence based on an analysis of over 240,000 buyer-supplier contracts that when both mission criticality and service complexity are low, suppliers tend to bear most of the disruption risk by agreeing to fixed-price contracts. When mission criticality is high, we find that the federal government is more likely to share risk with suppliers by utilizing incentive contracts. Evidence suggests that cost-reimbursement and incentive contracts are preferred when service complexity is high.